VAL - Transocean: Falling Oil Prices Sink All Ships

2023-12-08 06:24:37 ET

Summary

• Transocean's stock value has decreased by about 35% from its high in August, reflecting the weakness in the oil market.
• The company's balance sheet shows high debt and liabilities, which is a concern for investors.
• Despite challenges, Transocean is seeing an increase in average daily rates and a growing backlog of contracts, indicating an elusive turnaround.

Introduction

The Switzerland-based Transocean Ltd. (RIG) is an offshore drilling company I have followed on Seeking Alpha for nearly a decade. I currently own a small long-term position and regularly trade RIG short-term using a LIFO strategy.

I recently reported the company's third-quarter results on November 2, 2023, and I recommend reading it to familiarize yourself with the necessary basics.

Considering the recent weakness of the oil market, it is an essential exercise that will assist you in acquiring a true actionable perspective and avoiding quick decisions that end up being painful mistakes most of the time.

Given the recent dismal stock performance, which has many investors concerned, this exercise is critical. The stock value has decreased by about 35% from its high from August to October , with a capitulation day yesterday. By the way, It is not simply attached to RIG but to the whole offshore drilling industry, as shown below:

Is there a problem with Transocean's balance sheet? I would say yes.

To briefly illustrate the balance sheet situation here, I said in my preceding article:

To put it briefly, the quarter was disappointing, exhibiting unexpectedly low figures that deviated from the company's projections.

On the positive side, the average daily rate rose sharply in the third quarter and is anticipated to continue climbing through 2024, possibly surpassing $430k daily.

The third quarter average day rate increased to $391.3k/d from the year-ago level of $343.4k/d, up 13.9%. Utilization dropped to 49.4% from 59.4% in the same quarter a year ago.

Day rates
1Q22
2Q22
3Q22
4Q22
1Q23
2Q23
3Q23
The average daily rate is /d
334.5
358.1
343.4
348.6
364.1
367.0
391.3
Average Utilization
52.7%
58.2%
59.4%
49.4%
51.9%
54.7%
49.4%

Contracts are returning due to powerful demand, and the backlog is again expanding nicely. In September 2023, the backlog amounted to $9.4 billion , a noteworthy development suggesting a robust turnaround with legs.

CEO Jeremy Thigpen said in the conference call:

since the fourth quarter of 2022, our ultra-deepwater fleet average day rate has increased by approximately 33% to $416,000 per day. By the third quarter of 2024 based upon current firm backlog, we expect this average rate to increase to $437,000 per day.

However, the pace of the increase is approaching an asymptote or resistance that will be extremely hard to cross, as shown in my chart below.

• The first challenge raised at Transocean and the offshore industry, in general, is that because of its powerful correlation with the price of oil, the industry is subject to sharp swings that put a long-term investment at risk, particularly when the company is not paying dividends. A characteristic is that, as a service, offshore drilling often experiences rapid setbacks and gradual recoveries based on the state of the oil market.
• The second challenge is what I called a fundamental flow in my previous article. Put another way, an offshore driller is crumbling under crushing costs, which forces the company to take on more debt, pay high interest rates, and carry out additional capital expenditures, all of which sharply reduce free cash flow, which is often negative.

I said in my preceding article.

This problem had been deeply rooted in the business model. Drillships, HE Semisubs, and HE Jackups are very expensive to build, have a limited operational lifespan, and require expensive maintenance and running costs (5-year SPS, for example, could go as high as $100 million).

• The third challenge is the company's massive debt and liability load, which it has to shoulder without hope of relief due to a recurring lack of income. This financial situation is the direct consequence of avoiding bankruptcy in the first place. Transocean lost the chance to start fresh, much like Valaris, Seadrill, etc., by dodging bankruptcy. Though it was a mistake in terms of business strategy, many shareholders were spared a devastating loss. In my preceding article, I said:

As of September 30, 2023, net debt was approximately $6.792 billion , up from $6.242 billion during the same period the previous year. September 2023's total liabilities, including current, were $9.69 billion , up from $9.64 billion in 4Q22.

Liquidity was approximately $1.4 billion in 3Q23. However, the total cash was $594 million , down sequentially.

The total cash dropped significantly this quarter and it is not a good sign. Another unsettling issue is that the shares outstanding diluted for 3Q23 jumped to 774 million shares , up 8.4% on a one-year basis.

Is it back to square one? Not really.

Transocean is one of the numerous offshore drilling companies back in business today after a long and painful debt restructuring followed by a "clean" restart, resulting in a total disintegration of the shareholder's value.

However, what differentiated Transocean slightly from many of its peers is that it avoided a restructuring under Chapter 11 in 2020. It was a close call, though, with RIG closing at $0.67 on October 30, 2020.

On October 7, 2020, according to Politico:

The world's largest owner of deep-water oil rigs recently engineered a bond swap to trim some of its $9 billion debt load and ease the crunch caused by slumping energy prices. But other creditors, led by Whitebox Advisors LLC and Pacific Investment Management Co., say the transaction amounts to a default because it pledges assets that Transocean already promised to them. They've given the company until Dec. 1 to cure the default, according to a court filing.

Seadrill ( SDRL ) filed for Chapter 11 twice! Noble Corporation (NBLWF), Diamond Offshore ( DO ), and Valaris ( VAL ) went through the process as well in 2020.

Shareholders were wiped out, which is sadly normal when the company filed for bankruptcy.

Worse, and it should serve as a warning for things to come if the oil price cannot hold above $50 a barrel, is that the last time the market had an oil supply massive surplus, Saudi Arabia and Russia forced oil to dive to the low $30 per barrel, which put a chokehold on US production, including offshore drilling in the Gulf of Mexico. If you think it is not possible, think again harder.

The stock went from $84 to $46 from June to December 2008, albeit RIG had very little debt then. However, with nearly 7 billion in debt, what will this look like if history repeats itself?

In my opinion, this scenario won't hold true in 2024 or 2025. Nonetheless, I have frequently been taken aback by the market's trajectory, and we should never rule out any option simply because it doesn't align with our viewpoint.

The oil outlook is critical.

The oil markets have always been in crisis mode as far as I can remember, balancing several economic and geopolitical variables. One factor that can have a big impact on oil prices is the possible escalation of the Middle East conflict.

Expectations that too much oil will be available to meet the global economy's demand have led to a widespread decline in crude prices during the past two months.

Additionally, the outlook for global economic growth indicates that an acute economic slowdown or potentially a recession might substantially affect the oil demand in 2024 despite Saudi Arabia, a significant oil producer, strongly interested in maintaining high prices and willing to cut supply even more if necessary.

It is confirmed by the soft landing scenario suggested by the FED. Further news this week indicated that the Federal Reserve might be prepared to maintain current interest rate levels. It is widely anticipated that during its impending interest rate meeting, it will maintain its main interest rate at the highest level in over 20 years.

Oil stocks had a major correction on December 6, 2023, following another significant decline in the price of crude oil, now 3.2% below the price six months ago. Oil prices fell to their lowest point since June.

What to do?

I believe it is difficult to suggest RIG as a long-term contender. To the best of my memory, the company regularly generates negative free cash flow, often disappointing earnings, and shows a massive debt load. I do not see this financial environment changing drastically in the next few quarters.

As I often said in my preceding articles, RIG should only be used by a specific kind of trader looking for high-risk/reward potential, not a part of a savvy investor's portfolio.

However, with an adapted trading LIFO method, you can profit well, avoid sleepless nights, and establish a great recurring gain that you can safely use to build up a long-term RIG position derisked.

Technical Analysis and Commentary

RIG creates a descending channel pattern with resistance at $6.40 and support at $5.70. At 32, the RSI is flashing a buy signal. With the realization of the death cross (see chart above), we might be nearing the end of the correction.

Descending channel patterns are short-term bearish in that a stock moves lower within a descending channel, but they often form within longer-term uptrends as continuation patterns. Higher prices usually follow The descending channel pattern but only after an upside penetration of the upper trend line.

I would advise you to hold a small, long-term position in Transocean Ltd. and to trade LIFO with 70–75% of your holdings while you wait for a higher final price target of $8.50 to $9.50 for your core position.

I recommend selling gradually between $6.30 and $6.50 , with higher resistance at $7 . If support fails, I advise holding off on adding until a retracement occurs between $5.85 and $5.55 with lower support, which might be found at $5.35 .

Warning: The TA chart must be updated frequently to be relevant. The chart above has a possible validity of about a week. Remember, the TA chart is a tool only to help you adopt the right strategy. It is not a way to foresee the future. No one and nothing can.

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